On April 25, 2024, the U.S. Department of Labor (the “DOL”) finalized a collection of regulatory changes in its ongoing quest to update the definition of a “fiduciary” under ERISA and Section 4975 of the Internal Revenue Code (the “Regulation”).  In finalizing the Regulation, the DOL sought to confer ERISA fiduciary status on professional investment advisers and wealth managers, particularly with regard to participant-directed 401(k) plans and individual retirement accounts.  Along with the Regulation, the DOL published amendments to a collection of prohibited transaction exemptions (the “Amended Exemptions”).  The Regulation becomes effective on September 23, 2024.

This is the DOL’s third attempt to update the definition of an “advice fiduciary” and, like the prior attempts, it has already been challenged in the federal district court in Texas.

Changes to the Definition of Fiduciary under ERISA and Section 4975 of the Code

The Regulation replaces the existing 1975 regulation, which set forth the “5-Part Test” to determine if an individual is providing investment advice as an ERISA fiduciary.  Under the Regulation, a person providing non-discretionary investment advice to a plan participant or fiduciary is an ERISA fiduciary if (i) that person represents or acknowledges that they are acting as a fiduciary under ERISA with respect to the recommendation or (ii) for a fee or other indirect compensation,: (1) the person either directly or indirectly (e.g., through or together with any affiliate) makes professional investment recommendations to investors on a regular basis as part of their business; and (2) the recommendation is made under circumstances that would indicate to a reasonable investor in like circumstances that: (a) the recommendation is based on review of the retirement investor’s particular needs or individual circumstances, (b) reflects the application of professional or expert judgment to the retirement investor’s particular needs or individual circumstances, and (c) the recommendation may be relied upon by the retirement investor as intended to advance the retirement investor’s best interest.

In the Preamble to the Regulation, the DOL states that it views a “recommendation” as a communication that, based on its content, context and presentation, would reasonably be viewed as a suggestion that the retirement investor engage in or refrain from taking a particular course of action.  The Regulation makes clear that recommendations to distribute or rollover assets are fiduciary advice, as are recommendations as to the investment options in a participant-directed plan’s menu.  The DOL states that it aims to align the definition of “recommendation” with guidance adopted by the Securities and Exchange Commission (the “SEC”) and other governmental agencies; however, the DOL rejected suggestions to limit the new rules to “retail” plan fiduciaries and participants.

The Regulation is clear that written statements disclaiming fiduciary status, or that the recommendation may not be relied upon, will not control to the extent such statements are inconsistent with the other oral or written communications, marketing materials, other interactions with the retirement investor, or applicable state or federal law.

Amendments to Prohibited Transaction Exemptions 75-1, 77-4, 80-83, 83-1 and 86-128

The Amended Exemptions are an attempt by the DOL to unify the requirements across exemptions for persons providing non-discretionary investment advice.  The primary changes to Prohibited Transaction Exemptions (“PTE”) 75-1, 77-4, 80-83, 83-1 and 86-128 were the removal of any relief for prohibited transaction by advice fiduciaries.  If a discretionary investment adviser is relying on one of these exemptions, a review should be made to confirm that the changes do not impact the adviser.

Amendments to Prohibited Transaction Exemptions 84-24 and 2020-02

PTE 2020-02 permits various types of otherwise prohibited compensation to be paid to advice fiduciaries and their affiliated financial institutions, as well as certain principal transactions, provided that the conditions of the exemption are satisfied.  Those conditions include:

• a written acknowledgment of ERISA fiduciary status;
• disclosure of the services provided and any material conflicts of interest;
• adherence to the impartial conduct standards;
• adoption of policies and procedures prudently designed to ensure compliance with the impartial conduct standards and mitigate conflicts of interest; and
• engaging and documenting an annual retrospective compliance review.

Among other requirements, the reasons for a distribution or rollover recommendation must be disclosed to the plan participant and documented.

PTE 84-24 allows fiduciaries to receive compensation when plans and IRAs enter into certain insurance and mutual fund transactions recommended by the advice fiduciary (or its affiliates), as well as certain related transactions.  The amendments to PTE 84-24 cover compensation to “Independent Producers” (i.e., that sell insurance products of two or more unrelated insurers) selling annuities or other insurance products not regulated by the SEC, if certain conditions are satisfied, including that the Independent Producer acknowledges fiduciary status and meets certain disclosure requirements and conduct standards similar to PTE 2022-2.  The insurer whose policy is sold is required to establish appropriate policies and procedures and meet other criteria also similar to PTE 2002-2, but will not be required to acknowledge fiduciary status and will not be treated as a fiduciary simply by virtue of such supervisory activities.

The amendments to the Amended Exemptions are also effective on September 23, 2024; however, required compliance with PTE 84-24 and 2020-02 will be phased in so that the relief will apply generally if the investment professional or financial institution adheres to the impartial conduct rules and acknowledges its fiduciary status, with the other procedural conditions becoming applicable on September 23, 2025.

Impact on Investment Managers that Provide Wealth Management Services

Clients that provide wealth management or other holistic investment services to individuals or smaller employers should consider their relationships in light of the Regulation.  If the expanded definition of investment advice will make you an ERISA fiduciary, then the review of your services, preparing the required policies and procedures, educating your employees and providing the appropriate disclosures will be a significant undertaking.  If you are already relying on PTE 2020-02, the amendments, while not major, will still require a review and update to your existing policies and procedures.

Impact on Investment Managers of Private Funds and Other Institutional Clients

The Regulation should not have a material impact on investment managers of private funds that are subject to ERISA or that manage separate accounts for ERISA plans (i.e., discretionary fiduciaries).  However, even if your firm does not have a retail business, the Regulation may nevertheless impact your relationship to ERISA plans and IRAs.  If you utilize non-discretionary sub-advisers, use “finders” for investments, or make co-investments, those arrangements should be reviewed and may need to be modified.